If the firms are unsuccessful in raising capital they will effectively be in run-off, says S&P

Standard & Poor's has lowered its financial strength ratings on XL Capital Assurance (XLCA) and XL Financial Assurance (XLFA) to 'BBB-' from 'A-'. The ratings remain on creditwatch with negative implications.

The downgrade reflects the rating agency's current assessment of potential losses on the companies' 2005-2007 vintage RMBS exposure, direct and indirect, which is higher than previous estimates.

In S&P's view, XLCA and XLFA's combined capital cushion is inadequate at the previous rating level to absorb those losses, resulting in a shortfall of approximately $500m.

The companies have presented various strategies to address the capital shortfall, but in our opinion, management has been unsuccessful in its efforts.

The companies' franchise is impaired due to their scaled-back underwriting activity and concerns about the companies' ability to address prospective capital needs.

Management, however, is in the early stages of working toward restructuring the companies with a near-term business strategy of participating in the financial guarantee reinsurance market and selected areas of the primary insurance market.

In S&P's view, the success of the reinsurance strategy is dependent upon the ability of the companies to attract willing cession partners in a crowded financial guarantee reinsurance market.

The CreditWatch reflects the view that there is execution risk in the companies' restructuring plan and strategy for increasing claims-paying resources.

Should the companies prove unsuccessful in their restructuring and increasing claims-paying resources, XLCA and XLFA would effectively be in runoff, in which case the ratings could go lower.